“Asset allocation can be the distinguishing factor between a good retirement income and a wasted opportunity," says Tom McPhail, head of pensions research at Hargreaves Lansdown. A significant determinant of overall investment return, asset allocation is the division in your portfolio between cash, bonds, property, equity and commodities.
Of these, equities usually form the bulk of a pension portfolio. Mr McPhail says: “As research by Fidelity has pointed out, the three key determinants of a decent pension are: adequate levels of contributions, saving for long enough and investing in equities.
"You can then drill down and look at different sectors within equity markets, as well as the funkier, riskier stuff like private equity investing."
Mr McPhail points to the Barclays Equity Gilt Study which shows that over an 18 year term, equities have a 99 per cent probability of outperforming cash and a 91 per cent probability of outperforming gilts.
Whether equities are indeed the panacea when it comes to securing a suitable retirement income from a Sipp depends largely on the individual investor's attitude to risk and as Peter Heckingbottom, investment director at Leeds-based IFA Pearson Jones points out, the risk averse investor may very well choose to steer way clear of today’s volatile equity markets when deciding on what investments should be going into their Sipp.
He explains: "To use an extreme example - someone with a very conservative attitude to risk might want to remain wholly invested in cash. This is not such a bad idea, given that you will be getting a reasonable return of between 7.05 per cent and 7.1 per cent fixed on 12 months and should interest rates indeed fall, as predicted, then this could turn out to be an even better deal. Hence the idea of keeping a Sipp wholly invested in cash is not that much out of the question as one might have originally believed."
At the other end of the risk spectrum, some investors will have a fully invested Sipp with no cash. "This is where investors are suffering," says Mr Heckingbottom, "given the current market conditions and the fact that these investors have no available liquidity to finance income and costs."
A Sipp should be managed like any other investment portfolio, according to Philip Hutchinson, head of corporate Sipp sales at Pointon York Sipp Solutions, and a range of different factors, including risk, determine the portfolio breakdown. He explains: "Factors to consider, include your age – in particular how far you are from retirement, your financial circumstances – are you in debt or not, and also the cost of investment versus the return rates.
"Investors who will enjoy the most advantages from having a Sipp will be those who use their Sipp as a flexible investment vehicle, continually reviewing their investment strategy and adjusting their portfolio to suit their risk appetite and life stage."
Ideally a Sipp should not be stagnant and successfully managing this pension vehicle means taking control of the broad asset mix of your portfolio and adjusting this accordingly as one approaches retirement.
According to Mr Heckingbottom young professionals in the accumulation phase of their lives and still some way from retirement can achieve fantastic returns in their Sipp portfolios from investing globally. He explains: "I suggest quite a strong weighting in emerging markets such as Asia and Japan as a good place to start. As one moves closer to retirement one would then progressively move to a far more standard portfolio which is much more stable and mature."
Mr McPhail agrees with this sentiment, saying that for the younger investor, a diversified global strategy makes sense. "As a suggested starter portfolio one might look at a 25 per cent breakdown between four flagship global funds such as the Jupiter Global Managed Fund, Invesco Perpetual Pension UK Equity Fund, Artemis Global Growth Fund and the AXA Framlington Managed Balanced Fund, to provide diversification in terms of investment company style and management. This breakdown should appeal to both novice and experienced investors."
He continues: "I tend to favour a strategy of using UK Equity income funds as core holdings – such as Invesco Perpetual, Artemis, Jupiter, Psigma and then making specific overseas sector ‘bets’. So for example I have money in European equity income, and in corporate bonds; I also have money invested in riskier markets such as China, India, Russia and Latin America – these are all showing short term losses but I am holding on to them with a view to the longer term. I also have specific exposure to agriculture and to an environmental fund. These are simply an illustration of how you can develop a more diversified and perhaps somewhat higher turnover strategy as you get more involved in your investments."
For someone closer to retirement, Mr Heckingbottom recommends a greater weighting in cash and bonds, while reducing exposure to the more volatile equity markets and significantly reducing global investment exposure. He also suggests a move towards structured products such as UK structured product provider, Meteor Asset Management’s commodities plan, which will provide investors with the security that they will not lose their initial investment (see chart).
Mr McPhail agrees that a basic portfolio for someone nearing retirement should look at taking some of the risk off the table. The consensus being that in most cases it will make sense to shift one’s portfolio towards fixed interest and cash as one nears retirement. The Hargreaves Lansdown suggested Sipp portfolio for someone with around 10 years to retirement, comprises M&G Global Leaders, Psigma Income, CF Midas Balanced Income and Standard Life Investments Dynamic Distribution – with a 25 per cent stake in each of the four funds.
The point about approaching retirement is that you are moving closer to "decumulation" when you will use your capital to generate an income. Mr McPhail says: "Even if you are not going to buy an annuity all in one go, you will probably still want to reduce risk and put more emphasis on higher yield UK stocks."
While growth in the Sipps market has continued to accelerate over the past year with the market now exceeding the ₤50bn mark, Sipps have not been without their fair share of criticism and are often given stick for having exorbitant cost tags attached.
However, holding the right sort of assets can reduce the costs. Mr Heckingbottom says if you get it right, the costs attached to a Sipp often come in below that of a normal stakeholder pension. He says: "If one manages a portfolio properly say using exchange traded funds (ETFs) for the majority of the portfolio – if the ETFs are coming in at between 0.3 per cent or 0.4 per cent as a total expense ratio, and you are invested in cash which is nil because there is no charge attached to cash, and the advice fee stands at around 0.5 per cent, then you can get a fully advised Sipp with asset allocation and portfolio rebalancing at a cost of less than one per cent per year."
Mr Heckingbottom, however, admits that there are cases where Sipps can be more expensive than a stakeholder pension. "At the other end of the portfolio spectrum, if one is for example invested in multi-manager funds with a total expense ratio of around 3 per cent and you have an adviser taking one per cent and then still need to add to this the Sipp wrapper fees, you can find yourself paying in excess of four per cent per year. In my view, this is how not to run a Sipp."
Mr Heckingbottom agrees that a Sipp is a more suitable pension vehicle for the high net worth individual. "If someone has say ₤1,000 in a pension and the Sipp wrapper fees are costing them around ₤500 a year then they are never going to get a good deal. I think the minimum cut off point for investing one’s pension pot into a Sipp should be around the ₤50,000 mark in order to make this a viable option."
MODEL SIPP PORTFOLIOS AND FUND RECOMMENDATIONS
(source Peter Heckingbottom, investment director at IFA Pearson Jones)
|%||IN WORK||5 YRS TO RETIREMENT (Pre-USP)||RETIRE IN USP||ASP|
|Invesco Perpetual Corporate Bond||0||15||17.5||17.5|
|Invesco Perpetual High Income||5||7.5||7.5||10|
|Black Rock UK Smaller Companies||5||10||7.5||10|
|Schroder European Alpha Plus||10||5||5||5|
|L&G Japan Index||10||5||5||5|
|ASIA (EX JAPAN) EQUITIES|
|First State Asia Pacific Leaders||10||5||5||5|
|EMERGING MARKETS EQUITIES|
|Aberdeen Emerging Markets||30||5||5|
|CF Macquarie Global Infrastructure||10||5||5||5|
|Meteor Commodities (Structured Product 5 year timeframe)||0||5||5||0|